Islamic Banking in India : Stumbling at the Regulatory Block

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19 August 2009

Islamic banking has been on the rise in the Asia-Pacific region, accounting for 60% of the global Islamic banking market. However, despite its rise in the rest of the region, the penetration of Islamic banking in India has been low. This is especially surprising with India having approximately 154 million Muslims and being the second largest Muslim population of the world. As mentioned in the Celent report Rise of Islamic Banking in the Asia-Pacific Region, this is primarily due to a regulatory block which allows Islamic banking to operate only in the form of a Non-Banking Financial Corporation. An amendment in the Banking Regulation Act of India, 1949 is required to allow the Islamic banking system to operate in banks in India.

The primary reason for the regulation can be mainly attributed to the socio-religious nature of the Indian political scene. This is especially evident in the Raghuram Rajan Committee of Financial Sector Reforms report submitted to the Prime Minister of India last year. Although the report recommended principles based on Islamic banking, the term “Islamic banking” was deliberately replaced by “interest-free banking”. The committee recommended that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system. With this recommendation, the ball is in government’s court and it is up to them to come up with appropriate measures to introduce these products in the Indian banking sector. However, a rebranding of the various Islamic banking products must be done to achieve widespread acceptance and serve its foremost purpose of financial inclusion.

In addition to the regulations, some experts feel that the infrastructure for Islamic banking is not yet in place and steps must be taken in that regard. In fact, last week, Kerala State Industrial Development Corporation (KSIDC) announced setting up India’s first interest-free financial institution along Islamic banking principles in Kerala. It is beyond doubt that there exists a huge potential for Islamic banking in India. But, it will take strong policy decisions to tap the same.